Stockman Sees Fed-Fueled Bubble Bursting in Economic Chaos

The U.S. economy is in a bubble inflated by “phony money” from the Federal Reserve and will burst within a few years, warned David Stockman, who was budget director for President Ronald Reagan.

In an essay published yesterday in the New York Times, Stockman wrote that the Fed’s quantitative easing policies in the aftermath of the credit crisis have flooded stock markets with cash even while the “Main Street economy” remains weak. The combination, he wrote, is “unsustainable.”

“When it bursts, there will be no new round of bailouts like the ones the banks got in 2008,” wrote Stockman, a former senior managing director at Blackstone Group LP and a former Republican congressman from Michigan. “Instead, America will descend into an era of zero-sum austerity and virulent political conflict, extinguishing even today’s feeble remnants of economic growth.”

Stockman, 66, is the author of “The Great Deformation: The Corruption of Capitalism in America,” which will be published tomorrow. In a previous book published after he resigned as budget director in 1985, Stockman criticized his former Reagan administration colleagues for failing to cut spending along with the supply-side tax cuts they enacted.

“We’re borrowing money and burying the future generations in debt,” he said in an interview today on Bloomberg Television.

Ben Bernanke

The Fed, led by Ben S. Bernanke, is purchasing $85 billion in assets every month. The Fed is leaving its key interest rate near zero while it tries to reduce unemployment below 6.5 percent and hold inflation below 2.5 percent.

Those policies, Stockman said today, benefit speculators and bond traders and have created the “greatest bond bubble in history.”

The Standard & Poor’s 500 Index rose to a record high last week, closing at 1,569.19 on March 28. That surpassed the previous record of 1,565.15 set in October 2007. Today, the S&P 500 added 0.1 percent to 1,570.05 as of 9:40 a.m. in New York.

Among the other culprits Stockman blamed for what he termed a “state-wreck” are President Franklin Delano Roosevelt for weakening the gold standard in 1933, President Richard Nixon for removing the convertibility of dollars to gold and “lapsed hero” Alan Greenspan, the former Fed chairman, for keeping interest rates too low for too long.

‘Monetary Prison’

Investors will sell, Stockman wrote, at any hint that the Fed is starting to remove assets from its balance sheet.

“Notwithstanding Bernanke’s assurances about eventually, gradually making a smooth exit, the Fed is domiciled in a monetary prison of its own making,” he wrote, warning of unsustainable fiscal policies as well. “These policies have brought America to an end-stage metastasis. The way out would be so radical it can’t happen.”

In 2010, Stockman agreed to pay $7.2 million to settle a lawsuit with the Securities & Exchange Commission that claimed he had misled investors as chief executive officer of Collins & Aikman Corp., a maker of auto parts. He neither admitted nor denied wrongdoing.

Paul Krugman, the Princeton University economist and New York Times columnist, responded on his blog yesterday, saying that he was “disappointed” in Stockman’s “gee-whiz, context- and model-free numbers embedded in a rant -- and not even an interesting rant.”

Krugman called Stockman’s piece “cranky old man stuff,” and summarized it this way:

“We’ve been doomed, yes doomed, ever since FDR took us off the gold standard and introduced unemployment insurance. What about those 80 years of non-doom? Just a series of lucky accidents. Now we’re really doomed. I mean it!”